Recently gold prices endured a drop of over $100 in a sizeable correction following a strong rally. Those simply buying and holding for the longer term are perhaps not too worried by this, but at SK Options Trading we aim to avoid these corrections in an attempt to maximise our profits.

We successfully avoided this correction in gold, selling our positions in GLD June calls for significant gains before gold prices really started to plunge.

The highlights of our performance was banking profits of 116.67% and 108.52%.However, in total we had eight positions in GLD June calls, all of which were closed at a profit with an average gain of 50.29% per trade.

If we still held these trades they would be showing significant losses, so we are pleased we managed to sell at much higher prices.

Our model portfolio is up 337.77% since inception, an annualized return of 132.42%. This model portfolio is provided to all subscribers and gives suggested capital allocations with every trade, so that overall portfolio performance can be seen in a realistic manner and subscribers can make better use of our trading signals.

A $10,000 model portfolio would have grown to $43,779.52 before commission costs following our trading signals since inception.

So let us go into a little more detail about these recently closed trades. We bought call options on GLD, which means we thought gold prices would increase substantially. We bought these calls when gold was around $1350 and $1425 and sold them when gold was close to $1550, so our view was correct there.

The reasoning behind these trades was as follows:

From a technical perspective when gold was around $1350 we thought it was oversold and there was limited further downside. Gold prices fell to around $1310 after our initial buy but this did not bother us as we knew such a scenario was possible and it did not change our overall view. We signalled to buy more calls when gold was breaking above $1425 since we saw this as a key technical resistance level. Once gold had broken through this level we were of the opinion that it would rally significantly in the short term. We had also been studying the weekly Bollinger bands on gold, which are a measure of volatility. When the bands narrow that means volatility is less than when the bands are wider.

We sent the chart below to SK OptionTrader subscribers on March 2nd to share our thoughts.

We explained that the chart indicated to us a large move was about to begin in gold. The bands were narrow, which we interpreted as the calm before a storm. We felt the storm would take gold much higher and indeed it did.

On the 2nd of March in the same update we wrote to subscribers saying that “gold should rally past $1500 in the next couple of months” and gold hit $1500 one and a half months later.

We firmly believe in having “skin in the game” and “putting our money where our mouth is” and therefore we execute trades on our own account in accordance with the trading signals of SK OptionTrader and aim to replicate the model portfolio. However sometimes we go one step further and this year we offered a special deal to subscribers. Anyone who signed up for a year in January 2011 would get a full refund if gold prices did not reach $1500 in 2011. In other words we were saying, if we are right then you have paid for our services but if we are wrong then our services haven’t cost you anything.

We offered a similar deal in August 2010 saying "In fact we are so confident if you sign up to a 12 month subscription before September 1st 2010, we will refund your $179 fee if gold prices do not make a new all time high in 2010”. We have no plans to make any further special offers in the immediate future and in fact raised our prices on April 2nd to ensure we maintained a high level of service to all subscribers.

We also detailed in this update how we intended to buy more GLD June calls, and then in a separate email we signalled the trade and doubled our position in GLD call options:Having closed above $1425, gold appears to have broken out and could now run to $1500. Whilst we need a second close above $1425 to confirm this breakout, we are confident enough to warrant adding to our long positions in the next trading session. We will be targeting OTM GLD calls, looking at June 2011 expiration with strikes above $150, most probably $150 & $155.

We intend to close our current position in the $145 calls when GLD reaches $145, in favour of calls with higher strikes that are therefore more leveraged to the gold price.

In addition to the breakout above $1425, the weekly Bollinger Bands are looking very bullish for gold. The attached chart shows weekly gold with its Bollinger Bands and we have overlaid the BB width to further demonstrate our point. These bands (a measure of volatility) often tighten before a rally and at recently they have tightened considerably, having just now turned wider. If we are correct in our interpretation of these signals, gold should rally past $1500 in the next couple of months. In fact, $1500 is our most conservative estimate; $1550+ is more where we are expecting gold to go, however we will err on the side of caution.

So that was our technical reasoning, now for the fundamentals. Firstly there are the usual, standard reasons underpinning this gold bull market. The US dollar is terminally ill, the US economy is on shaky ground whilst inflation is rising, gold is an inflation hedge and a hedge against USD devaluation, therefore one should own gold. However these reasons have existed for some time and whilst they are useful from an investment perspective with a longer term time horizon, as a trading operation we have to do better than that.

What we like to do is look at is US real rates. This is the nominal yield, minus inflation expectations, on US government debt. We view it as a barometer of US monetary policy and therefore a key determinant in the price of gold over the short-medium term. For more information on this relationship you may wish to read our November article on the subject entitled: The Key Relationship between US Real Rates and Gold Prices. Basically gold prices have an inverse relationship with US real rates and the yields on US real rates were suggesting to us that gold prices should be a lot higher, which added to the argument to buy calls on GLD.

Now that we have covered our reasoning for opening these trades, we will now cover why we decided to close the trades a take our profits just prior to gold prices correcting.

1. Gold itself was overbought according to the indicators we look at, such as the RSI which was above 80.

2. Secondly the USD was oversold with its RSI below 30 and looked ripe for bounce back, especially when one considered the massive rally in the Euro which we believed was slightly overheated and the market had over-reacted to the ECB rate hike by instantly building in further hikes at following meetings.

3. The relationship between US real rates and gold did not make a strong case for higher gold prices in the intermediate term.

4. The target of $1500+ that we had set based on our analysis had been achieved and indicators such as the weekly Bollinger Bands we discussed previously, were not showing as strong a case for higher gold prices.

5. There was the seasonality of the markets to consider. The old adage of “sell in May and go away” often still applies and precious metals can often be weak or at least have limited upside during the summer months.

6. The calls we were holding expired in June. As options draw closer to expiration the decay of their time premium (Theta) accelerates and if gold simply went sideways or only increased moderately the call options may lose value as those who believe they will expire worthless begin selling aggressively given the shorter time until expiration.

7. We thought that the market positioning suggested that June calls could be sold heavily. We suspected that a lot speculators had bought June calls and were now sitting on significant gains (as we were) which they would like to take since expiration was now quite close. We thought June calls would go into liquidation mode as these players dumped gold options both on GLD and on Comex/Globex and we did not want to be caught on the wrong side of this.

Closing these trades brings our total number of closed trades to 78, 76 of which have been closed at a profit providing subscribers with a success rate of 97.43%. The average gain per trade is 41.95% and each trade is held for 46.45 days on average.

That means that $1000 invested in just one average trade would have paid for a six month subscription twice over, or more than paid for an annual subscription.

We have now closed 59 winning trades in a row.

So if you would like to join us then you can sign up below, we are currently planning our trading strategy going forward having taken significant profits, so now may be a good time to get on board.